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Terminate your retirement plan?

By Jeffrey B. Sansweet, Esq.

For the most part, primary care physicians who have sold their practices to health care systems have terminated their practice retirement plans within a year or so of the sale. Many physicians who remain owners of their practices have been considering whether to maintain their retirement plans. This article will discuss the factors involved in making such a decision.

The reasons for termination that I generally hear include the following:

• Increasing administrative expenses.

• Complexity and lack of understanding.

• Increasing costs to contribute to staff and lack of appreciation by staff.

• Excise taxes for accumulating too much money.

It is true that the expenses to administer even a small group’s retirement plan do generally rise each year. There is also complex legislation enacted annually which either requires plan amendments or operational changes. The legislation also generally has added new plan types and design options.

However, I believe that in almost all situations it makes sense to maintain existing plans. One major reason is the repeal of the 15 percent excise tax on excess retirement distributions and accumulations. Prior to the Small Business Job Protection Act of 1996, there was a 15 percent excise tax on retirement distributions in excess of $150,000 annually or $750,000 in a lump sum. There was also a similar tax upon death. The 1996 Act then created a window of opportunity by suspending the excise tax on distributions in 1997, 1998 and 1999. The Taxpayer Relief Act of 1997 unexpectedly repealed the 15 percent excise tax altogether. Thus, physicians will not be penalized for accumulating too much money in their plans.

Another change that will help physicians somewhat is the increase in the maximum compensation limit taken into account in calculating annual contributions from $150,000 to $160,000 for plan years beginning in 1997. In some situations (e.g., where the practice just maintains a basic 15 percent discretionary Profit Sharing Plan), this will allow for greater contributions for physicians. In addition, for plans that provide for “permitted disparity” at the social security wage base level, it will mean lower contributions required for the staff. For example, if the practice maintains a money purchase pension plan with a formula of 10 percent of pay up to the wage base and 15.7 percent of pay above the wage base, along with a discretionary Profit Sharing Plan, and the physicians maximize their contributions at $30,000, the practice’s required contribution for the staff would be reduced by 1.4 percentage points due to the increased compensation limit. That would equate to about $1400 in savings if total eligible staff salaries were $100,000. Incidentally, although the $30,000 annual contribution limit has not yet been changed, it will most likely be increased in the next few years.

The 1996 Act introduced a new type of plan, the SIMPLE Plan. The 1996 Act also changed some of the 401(k) rules. The 1997 Act then changed some of the IRA rules. The legislation has clearly made retirement planning more complex; however, it has also created more opportunities and has simplified some of the discrimination testing. The options are out there, and rather than be fed up with them and confused, it is best to seek out competent advisors to assist in working through the options and choosing the best.

Although the rules keep changing, the IRS has recently announced that plan documents need not be restated until the end of the plan year beginning in 1999. However, the plan must comply with all existing laws from an operational standpoint. Even if a plan is terminated prior to the 1999 plan year, it will still need to be restated.

If a plan is to be terminated, various paperwork, including a spousal consent, is required prior to distributing the funds to the participants. The distribution options would typically be a tax-free direct rollover to an IRA or a taxable distribution. With a taxable distribution, the law requires the plan to withhold 20 percent in taxes. In addition, if the participant is under age 59 1/2, an additional 10 percent penalty tax will be due. Thus, most physicians would typically elect an IRA rollover. One problem with going that route is that in some states (including Pennsylvania, but not New Jersey), IRA rollover funds are, for the most part, subject to the reach of creditors, while funds in a qualified retirement plan are beyond the reach of creditors.

One must also keep in mind that retirement plans are still one of the best tax shelters around. The practice gets a current deduction in full for the contributions made and the participants are not taxed on the contributions or the earnings that accrue until the funds are ultimately distributed to them from the plan or from an IRA rollover account. Although it is difficult to generalize, a good rule of thumb in terms of how much of the total contribution should be going to the physicians before reconsidering the program, is 60 percent to 80 percent. If the physicians are receiving less than that, either a new type of plan should be considered or possibly termination. If the plan is terminated, the funds would be available to either pay other expenses or as additional taxable compensation to the physicians.

A retirement plan is also a good marketing tool to attract good staff. And you can never underestimate the effect on staff morale upon termination of a plan.

Finally, one of the most important reasons to maintain a retirement plan, which has nothing to do with taxes or costs, is that it is a forced savings for retirement. In fact, the penalty for early withdrawal is there to try to help ensure that the moneys stay in the plan and are actually used for retirement income.

In conclusion, even in the tough times of decreasing reimbursements and increasing overhead, I believe it makes sense for most physicians to maintain their retirement plans.

Jeffrey B. Sansweet, Esq., is a principal in the Wayne, Pennsylvania health care law firm of Kalogredis, Tsoules and Sweeney, Ltd.

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